2012: Smart ways to save tax & take advantage of DTC

 

Over the next 90 days, millions of Indian taxpayers will wrap up their tax planning for 2011-12. Unlike in the past, this year's tax planning will be quite different as not only have the rules changed, but many of the goal posts have also shifted.

The biggest change is that the favourite tax-saving instrument of risk-averse investors has now become market-linked. The Public Provident Fund (PPF) will give returns that are 25 basis points above the benchmark yield of the 10-year government bond.

Then there is the Direct Taxes Code that may come into effect from April this year. There is also a small, but significant, change for senior citizens.

Last year's budget lowered the age limit for senior citizen taxpayers from 65 to 60. It also introduced a new category of very senior citizens above 80 with a big exemption of Rs 5 lakh. Despite these alterations, some fundamental principles of tax planning remain unchanged.

Your tax planning should still be guided by your overall financial planning. "Don't go by advertisements because not all tax-saving investments will suit you," says Mumbai-based financial planner Kalpesh Ashar.

Your choice of instruments should depend on how soon you need the money, your expectations of returns and ability to take risk. Let us look at the instruments that different types of investors should have in their tax-saving portfolio this year.

Take the ELSS advantage: For the taxpayers who embraced market risk by investing in equity-linked savings schemes (ELSS), this may be the last year for investing in this category. The DTC has not included ELSS in the list of tax-saving options. These funds have the shortest lock-in period of three years among all Section 80C instruments. So, your funds are not tied up for five years as in fixed deposits (FDs) and National Savings Certificates (NSCs).

"Given the three-year lock-in period and the level at which the markets are now, it is unlikely that an investor will lose money by investing in ELSS," says financial consultant Surya Bhatia.

The low minimum investment in these funds (you can start with as little as Rs 500) makes them an ideal stepping stone for the rookie investor.

However, don't forget that ELSS funds can be risky. So invest systematically rather than in a lump sum. Remember, you have to invest the money before 31 March.

"There is a lot of uncertainty in the market now and it is best to exercise caution and stagger investments in ELSS funds," says Ajit Menon, executive vice-president and head of sales and marketing, DSP BlackRock Mutual Fund.

Investors can also opt for equity exposure through Ulips. Unlike ELSS funds that cannot be touched during the lock-in period, these insurance-cum-investment plans allow policyholders to tweak the equity and debt allocation according to the market conditions. The New Pension Scheme also gives equity exposure, but this is limited to a maximum of 50% of the corpus.

Save extra Rs 9,270 through the PPF this year: The overall limit for investing in the PPF has been raised to Rs 1 lakh now from Rs 70,000 earlier. For someone in the highest tax bracket, this enhanced limit of Rs 30,000 means a potential tax saving of Rs 9,270 a year. "By itself, the PPF is a good long-term investment option, even if it is not done because of tax planning," says Bhatia.

 

 

Lock into tax-saving FDs at high rates : For the taxpayers who shy from market risk, fiveyear FDs are the only remaining true fixed income tax-saving instrument.

Even long-time favourites, such as the PPF and NSCs, have become market-linked. Even if the 5-year benchmark bond yield moves up to 9%, NSCs will offer an interest rate of 9.25%. Banks are already offering higher rates of 9-9.5%. For senior citizens, the Senior Citizens' Savings Scheme has become a little attractive.

It will offer an interest rate of 100 basis points above the 5-year government bond yield. But again, tax-saving FDs appear a better bet because banks offer senior citizens a 25-50 basis points higher rate of interest. Be careful with insurance:

For those who flocked to Ulips and insurance policies, there is uncertainty looming on the horizon in the form of the DTC. Under the DTC, insurance plans that don't give a life cover of at least 20 times the annual premium will not be eligible for deduction.

While the DTC is yet to be passed, there is no clarity for now on the new rules for tax deduction and taxability of insurance income.

These are among the various issues you will need to grapple with when you decide your Section 80C mix for this year. An early start allows you to make an informed decision. Leave everything for the last few weeks of the financial year and you are likely to make a suboptimal choice in your hurry to beat the 31 March deadline.

ET Wealth takes a look at the various investment options under Section 80C and explains the pros and cons of each of these investments.

EMPLOYEE PROVIDENT FUND

This compulsory deduction is also an automatic tax saver. Your monthly contribution to the EPF is eligible for tax deduction under Section 80C. The best part is the tax-free corpus. The only hitch is that you cannot access this money till you retire. If a subscriber is diligent, even if he gets a modest basic salary of Rs 25,000 at 25 years, and a 10% raise every year, his EPF will make him a crorepati by the time he retires. So, don't give in to the temptation of withdrawing your PF while changing jobs.

If you do this within five years of joining, not only will the withdrawn amount be taxed, even the tax benefits availed of in the previous years will be reversed. Some companies offer consultancy jobs with no EPF contribution. While this pushes up the take-home income, the employee is denied a crucial safety net and the chance to build a tax-free retirement corpus. 

 

 

 

PUBLIC PROVIDENT FUND

This option has become even more attractive after the interest rate was benchmarked to the 10-year government bond yield. This year, the PPF will earn 8.6%, 25 basis points above the average benchmark yield in the previous fiscal. The rate will be determined by the yields of gilt securities in the secondary market. This will ensure that the PPF returns are in line with the prevailing market rates.

The annual investment limit has been raised from Rs 70,000 to Rs 1 lakh. Both these changes mean that the PPF investors can build a bigger corpus in the 15-year period. While individuals can extend their PPF accounts beyond 15 years in blocks of five years, HUFs will no longer be allowed this facility.

When you invest in the PPF, the interest is compounded annually, but calculated monthly on the lowest balance between the fifth and the last day of every month. If you invest before the fifth, the contribution will earn interest for that month too. Keep in mind that you must invest at least Rs 500 in the PPF during a financial year or pay a penalty.

NSCs AND BANK FIXED DEPOSITS

Like the PPF, the interest on NSCs has also been linked to the government bond yield in the secondary market. The tenure has also been shortened by a year to five years. The new 5-year NSC will offer an interest rate that is 25 basis points above the 5-year bond yield. Through this step, the government has breathed new life into an instrument that had almost gone the way of T-Rex and its Jurassic cousins.

The government has also introduced a 10-year NSC, which will carry a coupon rate of 50 basis points above the 10-year bond yield. However, tax-saving FDs offered by banks are a better option. Even if the 5-year benchmark bond yield moves up to 9%, the NSC will offer an interest rate of 9.25%.

Banks are already offering higher rates of 9-9.5%. Sure, bank deposits cannot match the safety of a sovereign guarantee that the NSC carries, but if you choose a stable PSU bank or a reputed private bank, there is no reason to worry. 

 

 

SENIOR CITIZENS' SAVINGS SCHEME

This assured return scheme has also become a market-linked option from this year. The interest rate of 100 basis points above the 5-year government bond yield is attractive.

However, again, tax-saving FDs appear a better bet because banks offer senior citizens a 25-50 basis points higher rate of interest. This means the interest rate offered is almost 75-125 basis points higher than that offered by the SCSS.

The only good thing about the 5-year SCSS is that it gives a quarterly payout, which is very important for retirees. Plus, there is also the assurance of government backing. The only glitch: there is a Rs 15 lakh investment limit per individual.

This year's budget has removed an important lacuna in rules regarding senior citizens. Till last year, banks and the Senior Citizens' Savings Scheme considered an individual a senior citizen when he turned 60, but the taxman waited for another five years before extending him the benefit of a lower tax rate. The age limit for senior citizen taxpayers has now been reduced to 60 years.

EQUITYLINKED SAVING SCHEMES

Tax-free dividends, no tax on income, shortest lock-in period, flexibility of investments and potential to give high returns.

All this makes ELSS funds possibly the best way to save tax. However, it may be the worst way to avail of your Section 80C limit if you tend to be reckless with investments and if notional losses give you sleepless nights. ELSS funds carry the same risk as an equity fund, so the SIP route is the best way to go about it.

You may not have too much elbow room if you haven't already made some taxsaving investments for this financial year. Splitting Rs 70,000-80,000 into three monthly instalments before 31 March will not really serve the purpose.

However, if you plan to invest about Rs 15,000-30,000 in ELSS this year, split the sum into three monthly instalments of Rs 5,000-10,000 each.

Go for the dividend option if you want to book profits periodically. There are apprehensions that the ELSS option will end after the DTC comes into force. However, the industry expects that its representations to the Finance Ministry will be heard and the tax benefits restored.

ELSS is seen as a good way of initiating an investor into equity funds. "When the first-time investor will get good returns, he will start putting more into mutual funds and get into the investing habit," says Vikaas Sachdeva, CEO of Edelweiss Mutual Fund. 

 

 

UNIT-LINKED INSURANCE PLANS

Most invest in Ulips don't know what they are buying. Otherwise, why would they want to surrender a Ulip after the mandatory 3-5-year lock-in period? Just when the pain of the initial years is over and the gains have started, they exit the policy or stop paying the premium.

Buy a Ulip only if you can continue the plan for at least 12-15 years. Before that, the plan may not be able to recover the charges levied in the first few years.

Used well, a Ulip can be an effective asset allocation tool. For this, the investor should be aware of the switching facility as well as understand the various funds in which the Ulips can invest.

You can invest your Ulip corpus in equities as well as debt funds. Currently, long-term debt funds are attractive because of the possibility of a rate cut.

Look at the fact sheet of your Ulip to see which fund holds long-term government bonds and invest this year's premium in it. Use the debt fund even if you want to invest in equities.

Put this year's entire premium in the debt fund and then systematically transfer small amounts to the equity fund in monthly instalments of Rs 5,000-10,000. This way, you will be cushioned from the volatility in stock markets and gain from the rise in the bond market.

Make sure your insurance plan is DTC-compliant. The DTC says that to claim tax deduction and tax exemption on maturity, an insurance plan must offer a cover of 20 times the annual premium. Buy a plan only if it meets this criterion.

LIFE INSURANCE POLICIES

The default option for the lazy investor, traditional life insurance policies are perhaps the worst way to save tax. After Ulip charges were capped by the Insurance Regulatory and Development Authority (Irda), insurers have started pushing these debt-based plans.

The buyer pays a heavy price by getting returns that cannot match inflation and get an insurance cover that is too small to be of any significance.

"Customers can choose the specific insurance solution depending on their goals, but they should not compromise on addressing their insurance need," advises Deepak Sood, CEO & MD, Future Generali Life Insurance. Keep the DTC in mind when you buy a life insurance policy. While the DTC is yet to be passed, it has not explicitly stated whether the new rules for tax deduction and taxability of insurance income will be with prospective effect. However, it seems unlikely that the rule will be with retrospective effect.

If existing policies are also brought under the ambit, 95% of the policies will lose their tax benefits. Even so, don't buy an insurance policy only to get tax deduction and tax-free income. A PPF account will serve this purpose better. The tax deduction on life insurance brings down the effective cost of the cover. So, if you are in the highest 30% tax slab and pay Rs 10,000 a year for your term insurance cover, your effective cost is only Rs 7,000 a year. This should prompt you to buy a bigger term insurance cover. 

PENSION PLANS

This is a useful tool for retirement planning. There are three types of pension plans in the market. Unitlinked pension plans are sold by insurance companies. They offer greater transparency, flexibility and control to the investor. Just like a Ulip, you can tweak the asset allocation in your pension plan depending on your reading of the market and risk appetite. Buying one is fairly easy.

Then there is the New Pension Scheme, which also invests in a mix of equity, debt and money market instruments. The investor can choose any of the six fund houses to manage his investments. However, investing in the NPS is not an easy task because the intermediaries are not interested in selling a scheme that offers them a pittance in commission. There are other concerns as well.

Some of the NPS funds are routinely violating the investment mandate. The NPS itself has not been able to put in place the necessary back-end operations as envisaged in the original architecture of the scheme. You still can't buy from more than one fund house, thus limiting the choices for the investor. The simplest pension plans are those being sold by mutual fund houses.

The only thing that differentiates these plans from regular funds is the stiff penalty imposed on withdrawals before the investor turns 58. Before you invest in a pension plan, remember that on maturity only 33% can be withdrawn and the rest must compulsorily be used to buy an annuity.

This annuity will pay the investor a monthly income. Till date it was possible to buy a pension plan from one company and shift to another for an annuity when the policy matured. Now, Irda wants that the annuity must also be bought from the same insurer. This is why many companies have stopped selling pension plans.

INFRASTRUCTURE BONDS

The new Section 80CCF gives you an additional tax deduction of Rs 20,000 invested in long-term infrastructure bonds. The higher the tax bracket, the more one saves in tax. An investment of Rs 20,000 will translate into tax savings of Rs 6,180 for those in the highest 30% tax slab (taxable income of over Rs 8 lakh a year).

If you factor in the tax savings as well as the tax on interest income, this is an effective return of almost 14.5% for an investor who exits after five years. For those in the lower 20% tax bracket (earning up to Rs 8 lakh a year), the tax savings will be lower at Rs 4,120.

In the lowest tax bracket (annual income of up to Rs 5 lakh), the investment will save Rs 2,060 in tax. One good thing about these bonds is that after the lock-in period, they can be sold in the secondary debt market. Experts say it is a good idea to invest in the long-term bonds at current rates and hold for a few years. Interest rates seem to have peaked out and when they fall, the value of these 9-9.25% bonds will zoom in the secondary market. 

 

 

HOUSING OPTION LOAN REPAYMENT

If you are paying a big EMI on your home loan, there may not be much left to invest in tax-saving options. But don't fret. The principal portion of your home loan EMI gives you tax benefits under Section 80C. This also brings down the effective cost of the loan. To optimise the benefits, take a joint loan with your spouse or parent.

Both co-owners of the property can separately claim tax benefits on the home loan. However, don't let the tax breaks tempt you to extend the tenure of your loan. The shorter the tenure, the better it is.

TUITION FEES

Fuming over the rise in your child's school fee? Here's the good part. The tuition fee paid for up to two children is also eligible for deduction under Section 80C.

This includes the tuition fee paid to any recognised educational institution, playschool and creche. Foreign colleges and universities and private coaching classes do not qualify for the deduction. Also, the fee has to be for the taxpayer's own children and not siblings, nephews, nieces or grandchildren. Also, the benefit cannot be availed of by both the parents.

If there's only one child, only one of the parents can claim the tax benefits on the school tuition fee. Otherwise, each parent can claim the tax benefit for different children.  

 

Source: Economic Times.

Navin Agicha.